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Deutsche.01.16.14 .pdf


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Deutsche Bank
Markets Research
Global

Foreign Exchange
FX Spot

Date
16 January 2014

FX Daily
The Dollar-Equity Puzzle
Being lulled into stable correlations is the trait of a market regime. So when
correlations change, one should take notice; it could signal a regime change.
Indeed, we believe last year marked just such a change. In the earlier “crisis”
regime of 2008-12, the dollar was negatively correlated to equities and so
viewed as a risk-off currency, developed markets were plagued with crises
from Lehmans to the Euro-area, and new frontiers were reached in G3 central
bank policy. The dollar was also extending its downtrend. All that changed in
2013. The dollar’s correlation to equities dropped to zero (first chart), emerging
markets were in crisis and “frontier” monetary policy was being unwound
(taper). The new regime will likely be of dollar strength and emerging market
crises, much like the second half of the 1990s. At the more micro level, the
shift in dollar-equity correlation also suggests that a sharp stocks correction
may not derail the dollar trend.
Fed taper and higher front-end yields will be very important for the dollar. But
so too will be a pick-up in capital inflows, most notably in equities. This helped
the dollar in its last uptrend in the second half of the 1990s. A current puzzle
has been that despite US equity outperformance versus the rest of the world
(e.g. MSCI EAFE), net equity flows to the US have plunged to their lowest
levels in history (second chart). But history shows that it takes time for US
equity outperformance to translate into a pick-up in net equity inflows. In the
1990s, US equities outperformed for the whole decade, save for 1993-94, but
equity inflows only markedly turned up in 1996. This reinforces our bullish
dollar conviction.

Figure 1: USD Correlation To Equities Now Back To Zero
100%

1y correlation between USD TWI and S&P500 (y/y)

80%

Figure 2: In 1990s, It Took Time For US Equity
Outperformance To Translate to Equity Inflows
US net equity flows as share of GDP (lhs)

2.0%

MSCI US: EAFE (rhs)

1.5%

60%
40%
0%

1.0
0.9

0.5%

-20%

0.8
0.7

0.0%

-40%
-60%

0.6
0.5

-0.5%

-80%
-100%

0.4
0.3

-1.0%
90 92 94 96 98 00 02 04 06 08 10 12 14

Source: Deutsche Bank

1.2
1.1

1.0%

20%

1.3

77 80 83 86 89 92 95 98 01 04 07 10 13
Source: Deutsche Bank

________________________________________________________________________________________________________________
Deutsche Bank AG/London


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